Since when is a payroll tax holiday responsible? Since Alice said so.

A payroll tax holiday could give a short-term boost to the economy, while other parts of Alice Rivlin's plan would raise revenue.

Jonathan Ernst/Reuters
Former Federal Reserve Vice Chairman Alice Rivlin addresses the 2010 meeting of the Wall Street Journal CEO Council in Washington, Nov. 16. Ms. Rivlin is coauthor of the Rivlin-Domenici plan that temporarily halts the payroll tax but also includes progressive pruning of tax expenditures and an add-on consumption-based tax.

I have to admit that when I first heard about the payroll tax holiday part of the Rivlin-Domenici (Bipartisan Policy Center) deficit reduction package, I gasped with disbelief and said “what?!” Nearly $700 billion in deficit-financed tax cuts in one year is part of a plan to get back to fiscal sustainability?

But then I saw the other tax policy components of the BPC plan, including the thorough and progressive pruning of tax expenditures and the add-on consumption-based tax, and I realized: this is certainly not a plan that shies away from the need to raise more revenue.

Here are a few reasons why I think the payroll tax holiday actually adds to the level of “fiscal responsibility” encouraged by the overall BPC plan:

  1. A payroll tax holiday is one of the most effective types of tax cuts (and fiscal policy in general) in providing short-term fiscal stimulus (increasing demand for goods and services, creating or saving jobs); the Congressional Budget Office estimates it has a high economic “bang per buck” because it follows the “three Ts” well: it’s timely, (well) targeted, and temporary.
  2. We know we’re going to continue to do lots of deficit spending over the next year or two. When the economy is in no shape to call for deficit reduction, we can still promote “fiscally-responsible” policies by making sure we get the most benefit for the amount of deficit spending that we do. That means we should be substituting high bang-per-buck policies for low bang-per-buck ones wherever we can–rather than just throwing more bucks at any old deficit-financed policies.
  3. The full (employer and employee) payroll tax holiday wouldn’t just have high bang per buck; it spends really big bucks, so it would presumably have a really “big bang.” It would make any proposed extension of the Bush tax cuts in the name of stimulus look downright wimpy. Perhaps it would take away that excuse from the policymakers (including President Obama) for their obsession over the Bush/Obama tax cuts.
  4. But meanwhile, the longer-term cost of extension of the Bush tax cuts is far larger than the one-year cost of the payroll tax holiday, and we all know how hard it is for politicians to let go of the Bush tax cuts, so extension of the Bush tax cuts (for any reason and over any period of time) looks fiscally irresponsible relative to the one-year payroll tax holiday.
  5. In other words, my fantasy is that this flashy and fresh payroll tax holiday proposal might steal the show and bump the (temporary or permanent) extension of the Bush tax cuts off of the legislative stage. (Yes, I know this would have to happen very soon.) Taking the Bush tax cuts out (for good) would be a very fiscally responsible outcome.
  6. Finally, having this large, deficit-financed proposal within the BPC’s overall deficit reduction package is a strong preemptive strike against critics who like to automatically dismiss fiscal consolidation proposals as out of touch with the reality of the currently fragile economy.

Bruce Bartlett is not so fond of this payroll tax holiday idea, because he doesn’t believe it would really be just temporary:

I just want to ask one question: What are the odds that Republicans will ever allow this one-year tax holiday to expire? They wrote the Bush tax cuts with explicit expiration dates and then when it came time for the law they wrote to take effect exactly as they wrote it, they said any failure to extend them permanently would constitute the biggest tax increase in history. Sadly, Obama allowed himself to fall into the Republican trap, but that’s another story. My point is that if allowing the Bush tax cuts to expire is the biggest tax increase in history, one that Republicans claim would decimate a still-fragile economy, then surely expiration of a payroll tax holiday would also constitute a massive tax increase on the working people of America. And what are the odds that the economy won’t still be fragile a year from now? Zero, I would say.

But I am generally a more cheery person than Bruce, so I have two simple reasons why I’m more optimistic about the payroll tax holiday being a truly temporary policy: (1) it’s so much more obviously a temporary proposal, because it’s labeled a “holiday” after all, and it’s too big to be imagined in any more than a one-year chunk; and (2) if such a “big bang” of this highly-stimulative tax cut were put in place, we really wouldn’t need any more stimulus beyond the first year.

Who would have thought I’d find a large deficit-financed tax cut to be one of the most intriguing and promising ways to promote fiscal responsibility?

(Alice Rivlin, you are one clever woman!)

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